Last Updated: 8:00am, Mar 06, 2014
AFTER The Edge Malaysia’s Cover Story of Feb 17, 1MDB issued a media statement challenging our analysis of what was happening at the country’s second sovereign wealth fund, which has accumulated debts of well over RM30 billion in five short years.
We would like to make a point-by-point response to the statement issued by its Corporate Communications Department.
POWER ASSETS: 1MDB in its statement said that to give a more accurate representation and valuation of 1MDB’s assets, it is vital to have more detailed knowledge of the operations and factor in other considerations such as precedent transactions for acquisitions of controlling stake, discounted cash flow, management expertise and potential growth of the business. Any valuation without detailed information is wrongly premised and inaccurate. The statement did not give any figures like cash flow and the internal rate of return (IRR) it was getting. However, a news portal had a story in which an unnamed government source claimed that 1MDB was getting a good double-digit IRR.
Our response: To recap, in our analysis of 1MDB’s power investments, we came up with an implied IRR averaging 4% for its portfolio based on the acquisition cost totalling RM10.85 billion and cash flow from the power plants. The latter was, in turn, derived from the assumption that the initial power purchase agreements (PPA) with Tenaga Nasional Bhd had an IRR of between 15% and 16% at the outset. This assumption was not something plucked out of the air as it was based on widely accepted industry yardsticks.
Our conclusion was that 1MDB had clearly overpaid for Genting Sanyen Sdn Bhd (now called Kuala Langat Power Plant Sdn Bh) and Tanjong Energy Holdings Sdn Bhd (now called Powertek Sdn Bhd). We also questioned why 1MDB was willing to pay at least RM2 billion more than it should have.
But let us assume that it is true, as claimed by the unnamed government source, that 1MDB was enjoying a double-digit IRR and assign a 10% IRR to the Kuala Langat power plant. This implies that the original PPA had an IRR of nearly 26%!
That would be more than double what a similar project is getting today and definitely higher than the YTL power plants, which everyone knows enjoyed the highest IRR because they were the first independent power producers (IPPs) in the country.
Our calculations of Kuala Langat have taken into account the fact that terms under its 10-year extension — the original PPA expires early 2016 — are less favourable and based on benchmark returns that are closer to market rates. Tenaga itself has estimated savings total-ling some RM1.5 billion over a four-year period under the revised rates for the Kuala Langat and Segari Energy plants combined.
While we fully acknowledge that our calculations are not precise without detailed information, the cash flow of a power plant is quite predictable and does not vary much from year to year. This is precisely why IPPs as an investment are widely seen to carry comparatively low risks.
Our analysis and the IRR calculations are purely mathematical.
In short, if 1MDB is now earning an IRR of at least 10% as claimed, then the return on the initial PPA has to be 26%. Conversely, if the IRR at the outset is 16% (our assumption), then the Kuala Langat plant is now making 0.5% returns.
It has to be one or the other. So, which is it?
Looking at some of the facts that are available, it would appear that the former scenario is highly unlikely.
For starters, an IRR of 26% for the Kuala Langat plant at the outset implies an annual cash flow of some RM520 million, on average, over the 21-year concession period. This is more than the RM400 million or so annual capacity payment it has been getting from Tenaga.
Alternatively, it works out to an average selling price of at least 17 sen per unit (assuming the fuel cost at 1995 levels and utilisation of 76% for the plant). Again, this far exceeds the 14.5 sen per unit selling price that the market has been told that Kuala Langat was getting back then.
To put this into perspective, YTL Power – generally seen as having the most lucrative “take or pay” PPA — had an average selling price of 15.5 sen per unit. So, it is impossible that Kuala Langat enjoys a higher selling price.
In any case, if the original Kuala Langat PPA signed with Tenaga did indeed give the IPP an IRR of 26%, then the Tenaga board and management should be hauled up. But we do not believe that was the case.
To erase all doubts, we urge 1MDB to open its books and show us the numbers that it was getting “good double-digit IRR” as claimed from the RM10.85 billion acquisition of Kuala Langat and Powertek.
EXTENSION OF TIME AND CHANGE IN AUDITOR: 1MDB said it was granted an extension of time to finalise its March 31, 2013, accounts because it wanted to consolidate several new subsidiaries with large assets worldwide. It also said a change in auditor was nothing unusual in the corporate world
Our response: Yes, it is not unusual to change auditors. But IT IS UNUSUAL for any company to have three auditors in five years. 1MDB has used Ernst & Young, KPMG and now Deloitte. It has only one more of the Big Four left - PricewaterhouseCoopers. Furthermore, the change to Deloitte should by right be only for the March 31, 2014 accounts and not for that for March 31, 2013. The fact that 1MDB is unable to close its 2013 accounts at a time when its 2014 accounts are soon to close, together with the change in auditor, can only give rise to suspicion that KPMG may have refused to sign off the 2013 accounts.
EARNINGS FROM CAYMAN-BASED FUNDS: 1MDB said that its Cayman-based fund has invested with regulated and licensed international fund managers. Basically, it said that the US$2.32 billion (RM7.09 billion) is safe and indeed the funds have paid returns of US$200 million (RM606 million) to 1MDB.
Our response: In the name of transparency, we would like 1MDB to name the fund managers it has appointed to manage the money and where they are based. We would also like it to reveal whether the money is in the Caymans or is it with the Hong Kong unit of a small Swiss private bank?
Do name the bank/s where the US$2.3 billion is placed. The US$200 million is a good return onthe US$2.3 billion. Nonetheless, investment is about risks and returns. As 1MDB is a sovereign wealth fund (that is, owned by the people of Malaysia), it must have investment guidelines just like EPF and PNB would have. So do tell us what the guidelines are and what sort of investments the funds have invested in. After all, the EPF and PNB make these disclosures. Having accumulated over RM30 billion in debt and with US$2.3 billion parked with these fund managers, we can’t afford to have murkiness in the way taxpayers’ money is managed.
TUN RAZAK EXCHANGE (TRX): 1MDB did not touch on TRX in its statement but to refute our suggestion that it had to get a sweetheart land deal from the government to shore up its financial accounts, the government source quoted by the news portal claimed the purchase of the TRX and Sungai Besi land were at arm’s length. And that this was no different from Khazanah Nasional’s Medini land deal in Iskandar, Johor.
Our response: How can 1MDB say that the acquisition was on an arm’s length basis when what it paid was much lower than market price? In 2009, 1MDB bought the 70-acre (28ha) site for RM320 million or RM105 per square foot (psf). Our checks of land transactions in the vicinity in 2009 showed that the average vacant land price was RM543 psf.
This means that 1MDB got the land dirt cheap. Alternatively, it also means that had the government opened up the land sale to competitive bidding, it could have received RM1.65 billion or RM1.33 billion more than the RM320 million paid by 1MDB.
As for the argument that what it was doing with TRX is no different from what Khazanah is doing in Medini, it is totally flawed. Why do we say so?
Firstly, Medini and Iskandar are greenfield developments away from existing commercial hubs, so special incentives have to be given to develop them. TRX, on other hand, is right in the centre of Kuala Lumpur bordering the Golden Triangle. In other words, the government could have tendered out the TRX land for bids by private developers that would pay much more than 1MDB did, and would not require tax incentives.
Furthermore, Khazanah and its related companies have invested RM4 billion in building the infrastructure of Iskandar and has also drawn around RM10 billion worth of catalytic investments like Legoland, Johor Premium Outlets, Pinewood Studio, and educational institutions like Newcastle Medical University, Marlborough College, and Management Development Institute of Singapore.
Total committed investments in Iskandar to date is RM130 billion.
What has 1MDB done with the TRX land apart from revaluing it to show a profit for itself?
Ho Kay Tat is the Publisher and Group CEO of the The Edge Media Group. This article was first published in The Edge Malaysia of March 3.
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